ataxingmatter

Capital Gains--yesterday was good legislation day, today's a bad bill discussion day

Not a surprise, but the GOP in Congress is hoping to make permanent a rather lamentable part of the Bush revenue reductions--the 15% rate on capital gains AND dividend payments.  As readers know, those preferential rates are especially beneficial to the top of the tier in the US tax system--the uberwealthy who own most of the financial assets and reap most of the passive income by just sitting around and collecting.  Why ordinary Americans ever let Congress get by with enacting preferential rates for the primary income source of the super-rich is hard to fathom.  That is class warfare by deception, of course, as it is usually practiced in this country.  The wealthy rake it in, no matter what. 

The preferential rate for capital gains has no foundation in economic policy, though you will hear a lot about how the rate is intended to stimulate growth by providing more income to investors to reinvest.  Of course, there is never any requirement of reinvestment--and certainly no requirement of investment in US companies that create US jobs for ordinary US taxpayers. 

Then you hear a lot about how the people who have capital gains are the "real entrepreneurs" of the country, and we have to reward them (by letting them keep a larger proportion of their pre-tax dollars than their secretaries and landscapers can) so that they will keep on being entrepreneurs.  Bullshit.  First, they are not likely to be entrepreneurs, currently.  Maybe they were once, but like Bill Gates, they are monopolists now.  And even if they were once entrepreneurs, they are more likely to be wedded to old ways of doing it than to new, innovational, job-creating, history-changing ways.  And they may well have never been anything but the son (or granddaughter) of an entrepreneur, raised in silk stockings and better-than-thou status and incapable of even real noblesse oblige. 

So the next argument is all about how these people have put their hard-earned capital at risk to benefit all society, and deserve the preferential rates as a reward to that risk-seeking activity.  Riskiness, priskiness.  We had a little too much risk-seeking for our own good, and that has got us into this royal stew of an economic mess.  Besides, there's risk, and there's risk.  Risk that is just speculative betting on the markets (like a lot of AIG's credit default swap book) doesn't do anybody any good.  (Not even AIG, as it now knows.)  Risk that is taking a chance on a marvelous new innovation that could make a difference to people's lives, or save wolves, or create peach trees that yield fruit with half the water--now that, my friends, is entrepreneurialism, but it is more likely to come out of the Mississippi State University Ag and Tech department then out of financial capitalists invested in somebody's high stakes private equity or hedge fund.

So the fall back argument is--gee, but these financial capitalists invested their money for the long term, and half their gain is really inflation so they shouldn't be taxed on that.  Comeon, what a rip off that argument is.  the argument certainly doesn't apply to day traders.  Or even month traders.  In fact, you'd need a really long holding period before it would make much of a difference whether you took inflation into account or not.  And, after all, there is already that rather nifty little provision in section 1202 that provides an exclusion for HALF (yes, read it again, half) the gain when you've held stock since issuance and satisfied a few other long-term interest tests.  So if you made the rate applicable only for stocks held for 20 years or so, maybe I'd buy an inflation adjustment component to the gain calculation. Otherwise, nutty.

It's just plain unfair, as Dorothy Brown so eloquently wrote in the New York Times, to tax labor at double (or more, these days) the rate that financial asset income is taxed.  The Bushies did it because they were cronies with the big capitalists.  The Obama Administration should let those provisions die a painless death in 2010, as they are written to do.  Let dividends go back to being taxed like interest income.  Let capital gains go back AT LEAST to being taxed at the Clinton-era 20% rate.  Bush's favoritism for the wealthy financial-asset holding class should end.  It is class warfare at its worst.

But, no, here is Senator Crapo (what a fitting name, for this Republican from Idaho) with his introduction of crappy legislation S. 567 to make the Bush era giveaways to the wealthiest people in this country permanent by legislating the 15% rate for capital gains and dividends permanently into the law.  By the way, this is nothing new with Crapo--he has been offering bills to reduce the taxes paid by the holders of capital assets for years. He introduced a similar bill in February 2007, as S. 502 (this link provides a pdf of the earlier legislation).   He is one of these who claims that cutting tax revenues makes growth happen. See this release relating to S. 502.   Funny, considering how much federal revenues were cut by the myriad Bush tax cuts, why don't we have any growth at all right now?  Why are we in a catastrophic Great Recession, given the long-term tax cut rules that Bush and the GOP put into play?

The rest of Crapo's policies are of the same stripe.  Crapo voted in 2000 to proritize tax cuts above paying down the national debt--that was back when we had a surplus, before the Bush economic policies sent us down into the highest deficits since Reagan and the worst economy since the Great Depression.  He also voted NO on the bill that was intended to repeal the tax susbidy for companies that move US jobs offshore (March 2005), YES on restricting rules for personal bankruptcy in 2001, and votes pro-business 91 percent of the time.  He wants the government to kill more US citizens (broader use of death penalty, and making death penalty appeals harder to win) and build more prisons (more wasteful expenditure of funds on prisons instead of education).  He didn't like the idea of eliminating corporate tax loopholes so that we could shift money to education (March 2005) and would have been supportive of giving federal aid only to schools that allowed prayer (which he thought should be supported by a constitutional amendment).  He'd like to repeal the estate tax, and not have people that make more than a million a year pay more in taxes.  See here and related links for all of this.  He is rated 0% by Citizens for Tax Justice for his opposition to progressive taxation.  No surprises there.

I say.  No Way.  Hope the Congress has the sense to let that bill go.  Between the money we've already thrown at the wealthy financial asset- holding class through bailouts of the banks and AIG, and the money we are throwing at them through some of the business-friendly provisions of the stimulus package, it is high time to go back to the Reagan-era reform of making the rates on salaries and dividends or capital gains the same--no character distinction whatsoever.  Do I hear a second, anyone?

Tax Havens: legislation in sight?

[edited to correct typos 031209 8pm]

As Congress settles in under the new administration, it appears much more likely that it will finally take some kind of decisive action to prevent the various international tax scams that have permitted many U.S. taxpayers to avoid paying the amount of tax that they should pay under the system as it is intended to work.  The question becomes not--will Congress act to prevent some of the offshore abuses? but rather --how will Congress act to prevent some of the offshore abuses?

Representative Lloyd Doggett of Texas has been a long-time proponent of action to prevent tax sheltering activity that goes against the intent of the overall schema set out by the tax code, but it has been difficult to get support in the Senate for that action.  Now it looks like there is a much better chance for passage.  A new version of the "Stop Tax Haven Abuse Act" has been introduced by Senator Carl Levin in the Senate (with a similar bill introduced by Lloyd Doggett in the House).  Senate, House Members Introduce Stop Tax Haven Abuse Act, Sen. Levin's Office.  This is similar to the bill co-sponsored in 2007 by then-Senator Barack Obama, with three additions, in particular, that greatly improve the bill: 

(i) Section 103 of the proposal:  treating large traded foreign corporations as domestic if they are managed and controlled in the US;

(ii) Section 108 of the proposal:  closing the hedge fund dividend loophole that purports to convert taxable US dividends into nontaxable dividends, by treating  (for both US statutory law and US tax treaty purposes) dividend equivalents under notional principal contracts in respect of stock of domestic corporations as dividends sourced in the US, and substitute dividend payments (ie, payments made to a securities lender "in lieu of" the dividend the securities lender would have otherwise received) as dividends sourced as the dividend itself would be sourced, and also requiring appropriate withholding on the dividend payment; and

(iii) Section 109 of the proposal:  expanding passive foreign investment corporation (PFIC) reporting requirements for PFIC shareholders. 

See also New Legislation Would Combat Tax Haven Abuse, Increase Transparency and Accountability, Global Financial Integrity.org, Mar.2, 2009.

In general, the proposal aims to provide the IRS with the tools it needs to find noncompliance, to enforce the tax Code, and to make offshore tax shelters harder to do and less likely to pay off for taxpayers (and tax advisers). It sets up a number of rules that relate to "offshore secrecy jurisdictions", which are defined as any "jurisdiction that the Secretary of the Treasury determines to have corporate, business, bank or tax secrecy rules and practices [both formal and informal] which... unreasonably restrict the ability of the United States to obtain information relevant to the enforcement of this title..."  This definition would include Singapore, Cayman Islands, Liechtenstein, Switzerland, among others.  In looking at the activities of financial institutions operating outside the United States, it very appropriately treats impeding U.S. tax enforcement on a par with money laundering.  It requires unregistered investment companies (and that includes hedge funds and private equity funds) to "establish anti-money laundering programs and submit suspicious activity reports."  The proposal, in other words, demonstrates some maturity in Congress in the way it looks at the problems of international tax enforcement as on a par with similar problems in the banking/corporate/financial regulatory world.

 Finding noncompliance will be easier with improved disclosure and reporting provisions, including:

• reporting requirments for withholding agents in respect of beneficial owners of foreign-owned financial accounts and for financial institutions that open an account or establish an entity on behalf of a US beneficial owner in an offshore secrecy jurisdiction. 

Enforcement will improve because of procedural changes, such as the following:

• extension of the statute of limitations for returns connected with offshore secrecy jurisdictions;
• rebuttable presumptions of control and income in respect of certain transactions in offshore secrecy jurisdictions;
• increased information sharing between federal agencies, so that when banking or SEC examinations reveal a potential violation, it is reported to the IRS for investigation (see  Section 305);

I am particularly pleased to see this cooperation provision, since I recommended something along these lines in my first article on corporate tax shelters, see Putting SEC Heat on Audit Firms and Corporate Tax Shelters: Responding to Tax Risk with Sunshine, Shame and Strict Liability, 29 Journal of Corporation Law 219 (2004).

• strengthening of John Doe summons use in cases involving offshore secrecy jurisdictions;
• requirement that documents related to tax exempt determinations be provided on request to Congressional committees for review (for future disclosures, not retroactive); and
• instruction to the Secretary of the Treasury to impose standards for written advice with respect to any listed transaction or transaction that has a potential for tax avoidance or evasion (confirming the authority of the Treasury to issue written opinion standards).  

There'll be more muscle behind the enforcement actions, including the following:

• increased penalties for failures to report and for promoting tax shelters (replacing a penalty under section 6700 that was the lesser of $1000 or 100% of gross income with one that "shall not exceed 150% of the gross income" derived from the activity, for each instance) and similarly for aiding and abetting tax understatements;
• limits on the ability of a taxpayer to rely on a legal opinion for a "reasonable cause/good faith" affirmative defense from penalties for transactions involving offshore secrecy jurisdictions (unless regulations permit reliance where the confidence level "substantially exceeds more likely than not" or where the subsection should not apply to a particular class of transaction, such as corporate reorganizations); and
• denial of any deduction for certain penalties (and other amounts).

There are a number of other commendable provisions here.  To list just a few:

• Section 303 of the bill would amend section 101 of the Patent Act to make tax planning strategies ineligible for patenting, but leave tax preparation software patentable. Again, this is something I have written extensively about:  see  Tax Patents: At the Crossroads of Tax and Patent Law, 2008 Journal of Law, Technology and Policy 107; At the Crossroads, 121 Tax Notes (2008) (an updated article incorporating the Federal Circuit's opinion in Bilski); Tax Shelters and the Tax Minimization Norm: How does the Patenting of Tax Advice Transform the (Global) Playing Field, Journal of Law and Society (2008).
• Section 304 prohibits fee arrangements based on projected tax savings or losses that can be used to offset other taxable income. 

The bill also includes, in Title IV, Section 401,  a "clarification of the economic substance doctrine."  It indicates that a transaction will have economic substance only if it "changes in a meaningful way (apart from Federal tax effects) the tqaxpayer's economic position" and "the taxpayer has a substantial purpose (other than a Federal tax purpose) for entering into such transaction."   If the purpose is to garner a profit, the transaction won't be treated as "having economic substance solely by reason of having a potential for profit unless the present value of the reasonably expected pre-Federal tax profit from the transaction is substantial in relation to the present value of the expected net Federal tax benefits that would be allowed if the transaction were respected" taking fees and other transaction costs--including foreign taxes, if the Secretary so decides--into account.  Financial accounting benefits don't count as a purpose, if the origin of the accounting benefit is a reduction in tax.

I am of mixed views about changing this rather powerful judicial doctrine into a statutory rule.  In spite of the inability of courts to consistently apply the doctrine and thus the ability of skillful practitioners to create customized transactions to generate phantom losses that squeak by the courts, I worry that codification of the flexible judicial doctrine will result in stultification of a provision that has permitted the courts to interpret the Code in ways that are responsive to the inventiveness of tax practitions.  Once codified, tax practitioners may successfully limit the reach of the doctrine through interpretation of the statute, and it will make it possible for nonsubstantive transactions to escape the kind of judicial review that is currently possible.  

The bill is far from perfect.   But it is a start.  And it includes a number of provisions that I have argued for, both on this blog and in my scholarship, that will make the tax laws both fairer and more transparent. 

Another bill sponsored by Senator Levin in the Senate is the Incorporation Transparancy and Law Enforcement Assistance Act.  See this release.  This bill would require states to obtain information from incorporators about the beneficial ownership of new entities, with civil and criminal penalties applicable to fraudulent information.  Law enforcement agencies could obtain the information with a subpoena or summons. As Levin notes in the release, the ability to create dummy corporations that disguise ownership of business activities facilitates a variety of tax scams, for US taxpayers and for taxpayers of other countries using the United States as a tax haven.

[I]n a list of the “Dirty Dozen” tax scams in 2007, the IRS highlighted shell companies with unknown owners as number four on the list, as follows. “4. Disguised Corporate Ownership: Domestic shell corporations and other entities are being formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity. Once formed, these anonymous entities can be, and are being, used to facilitate underreporting of income, non-filing of tax returns, listed transactions, money laundering, financial crimes and possibly terrorist financing. The IRS is working with state authorities to identify these entities and to bring their owners into compliance.” That’s not all. Dozens of Internet websites advertising corporate formation services highlight the fact that some of our States allow corporations to be formed under their laws without asking for the identity of the beneficial owners. These websites explicitly point to anonymous ownership as a reason to incorporate within the United States, and often list certain States alongside notorious offshore jurisdictions as preferred locations for the formation of new corporations, essentially providing an open invitation for wrongdoers to form entities within the United States.

One website, for example, set up by an international incorporation firm, advocates setting up companies in Delaware by saying: “DELAWARE - An Offshore Tax Haven for Non US Residents.” It cites as one of Delaware’s advantages that: “Owners’ names are not disclosed to the state.” Another website, from a U.K. firm called “formacompany-offshore.com,” lists the advantages to incorporating in Nevada. Those advantages include: “No I.R.S. Information Sharing Agreement” and “Stockholders are not on Public Record allowing complete anonymity.”   Id.

The individual states have failed to address this problem satisfactorily, as serving as a tax haven has become just one more way for states to "race to the bottom" in competition with each other.  Levin indicates that the failure of the National Association of Secretaries of State to adequately address the problem demonstrates the need for federal legsilation to "level the playing field among the States, set minimum standards for obtaining beneficial ownership information, put an end to the practice of States forming millions of legal entities each year without knowing who is behind them, and bring the United States into compliance with its international commitments."  Id.  The bill has a huge loophole that could swallow the rule, however, allowing States to idenity "certain corporations, either individually or as a class" that would not have to comply with the rule.   See also Levin Grassley McCaskill Bill Introduced to Stop Misuse of U.S. Companies.

More on Madoff

Ponzi-schemer Bernie Madoff will apparently plead guilty this week to charges that could mean a life sentence for him, without a plea deal.  See Rashbaum & Henriques, Madoff Guilty Plea Expected; He Could Face Life in Prison, NY Times, Mar. 10, 2009.  Madoff purported to run an investment business managing $64.8 billion for 4800 clients.  He promised some of those investors annual returns of 46%.  Some investors were paid off with other clients' money, and he even used client money to finance the market-making business run by his sons.  Id.  All told, he may have paid "in the billions" to investors in the form of redemptions.

Madoff was charged with 11 felony charges--including securities fraud, investment advisory fraud, mail fraud, wire fraud, money laundring, false statements, perjury, false SEC filings, and theft from an employee benefit plan.  Id.   These charges carry a maximum of 150 years in prison.  And the government wants $177 billion, which Madoff's lawyer calls "grossly overstated" as a criminal forfeiture amount.

Clearly, Madoff's criminality represents an iconic image of the ills of Wall Street, when greed and status justify enormous harms to individuals  and the society at large.  Yet it isn't just individual criminals that are the problem with our economy today.  It is, in fact, the larger ethical lapse represented by Wall Street financial institutions that lies at the heart of the economic meltdown we are enduring.  Harvey Pitt, former chair of the SEC, suggested "there was criminality at a lot of these [Wall Street] firms" where different valuations of financial instruments were used depending on the purposes for the valuation.  "These kinds of things reflect more than happenstance or carelessness; they reflect criminality."  Strom, Elie Wiesel Levels Scorn at Madoff, NY Times, Feb. 26, 2009.

Direct Lending: Why Obama's Student Loan Proposal Should be Adopted

President Obama has proposed a major change in the way the federal government finances college educations for students.  Instead of the various federal loan programs that now have college administrators handling all the paperwork but banks receiving subsidies from the federal government (and very generous ones they have been, over the years), all federal loans should revert to the original direct student loan program, cutting out the middlemen banks.

This is a great idea.  The banks basically have been getting a welfare handout from the federal government ever since the GOP "privatized"federal loans--they make a hefty spread between the interest rates earned on these laons and the rates paid on money to fund the loans.  The federal government insures them against any default on those federally funded loans.  The 2007 College Cost Reduction and Access Act amended the Higher Education Act of 1965 in ways that made it less likely that the companies would be getting subsidized at too high a rate by cutting the interest rates and reimbursement rates on loan losses.  See

Note that the original justification for instituting a more expensive way to give federal aid to students was a glitch in the federal budget process.  The budget process didn't count direct lending repayments when it calculated the cost of direct lending.  Accordingly, the cost seemed to be much greater than it actually was, since the loan showed as a loss in the year that it was made.  On the other hand, the process looked favorably at privatized loans--since the governments payments for defaults and interest subsidies wouldn't be made until later years, they showed up as costing nothing.  See this history of the loan program.  Accordingly, even the heavily subsidized bank loans appeared to be saving the federal government money by comparison to the actually much cheaper direct loan program!  As a result, direct lending was eliminated, and the banks had a new gravy train--payment of a substantial spread just for putting their name on the loans (the federal government guaranteed that they wouldn't lose money on studetn defaults).

Finally, under Clinton in 1992, the direct lending program was reinstituted, but on a very small basis compared to the privatized program, being phased in over time, and allowing the Secretary of Education to require colleges to switch to it.  The expectation was that direct lending would ultimately replace guaranteed loans.   But the 1994 Republican "contract" on remaking the federal government instead targeted the direct loan program for elimination:  they preferred to completely privatize everything.  When universities complained that direct loans were much more efficient at getting aid dollars where they were needed than the cumbersome, middle man-heavy guaranteed loan apparatus, Congress instead refused to permit the Department of Education to encourage universities to move towards direct loan programs, which has resulted in a steady decline of the direct lending program during the Bush years, as desired by the financial institutions that profit from the privatized guaranteed loan program.  According to US News and World Report, the student loan industry "used money and favors... to get what they wanted."  See this history of the loan programs.

Now, Obama wants to come full circle and restructure the loan program, removing the handouts to intermediary banks.  It's obviously the right idea.  But will the Congressmen who've taken lots of campaign donations from Big Banks go along?  There's a great discussion of this on Angry Bear, Federal Family Education Loan (FFEL) Program, Mar. 7, 2009.

Higher Ed Watch (linked by Angry Bear) reports that the student loan industry has assiduously wooed "blue dog" Democrats and those with close ties to financial institutions.

[T]he student loan industry has gone to great lengths over the last two years to woo key Democrats.  Sallie Mae outlined this strategy in an internal strategy document it produced shortly after the Democrats took control of Congress in 2006. That document, which was obtained by Rep. George Miller (D-CA) and published on this blog, laid out the student loan giant's plans to target generous campaign contributions toward "Blue Dog and Financial Services Democrats," as well as members of the Congressional Black and Hispanic Caucuses. A Higher Ed Watch investigation in July 2007 found that Sallie Mae had lived up to its pledge -- donating, through its political action committee, more than $100,000 to members of these three groups in the first six months after the election.

Similarly, many colleges, according to Higher Ed Watch, have links to the loan industry, and may even assist the financial industry in lobbying against the Obama provisions.  They are touting the "FELP participant-provided services like college access programs, financial literacy education and loan delinquency and default prevention."  I am very skeptical about the value of those programs--especially as compared to the same kinds of programs offered by colleges and universities for their own students.

One commentator at Angry Bear makes a significant contribution to the discussion.  We spend upwards of $20,000 per year on each prisoner in the United States.  We spend only about half that much on K-12 education.  Yet education is the key to a sustainable middle class.   And the banks have fought bankruptcy relief for student loans in the same way that they have fought bankruptcy modifcation for loans on principal residences.

Something's gotta change.  The Blue Dog Democrats and those that are too close to the Big Banks need to step back and vote for the good of the country, not the quid pro quo for those campaign contributions.

the Capital Gains Preference

A fellow tax professor, Dorothy Brown, had a great op-ed in the New York Times yesterday, Two Americas, Two Tax Codes, NY Times, Mar. 8, 2009.  She discusses the basic fairness issue when those who have mostly income from financial assets (capital gains or dividends) pay tax at a much lower rate than those who have mostly income from labor.  The result is "two tax systems in American: one for the very rich and one for the rest of us."  And while the new President's tax policies are certainly better than those of the former occupant of the White House, they fall short of "address[ing] this significant disparity."

Fixing the hedge fund manager problem is a good idea--they should pay ordinary tax rates on their income from managing the hedge funds, not capital gains rates, becuase it represents compensation income.  And increasing the top rates for top income recipients (families with $250,000 or more, singles with $200,000 or more) is also a reasonable step.  Having wealthier families pay the old 20% rate on capital gains rather than the newer 15% rate is a help.  But none of these steps really introduces sufficient progressivity into the Code, and the last step is especially weak as a step in moving those with financial income into the same tax brackets as those with wage income. 

Brown notes that tax rates on capital gains have varied quite a bit over time, sometimes being taxed at the same rate as ordinary income but most of the time lower.  Stock dividends used to be taxed as ordinary income--until the GOP Congress passed the huge tax bills in 2001 and 2003.  Th3 2003 tax bill gave most dividends the same favored rate as capital gains, moving us "in the wrong direction".

Brown suggests that we should look at the "fundamental fairness" issues and treat financial income the same as labor income.  "[I]t's all income and it should all be taxed at the same rate."  If we want to make the system fairer, then we should increase the tax rate on capital gains, and consider allowing more excess losses to be used against ordinary income than the $3000 currently allowed.

Teaching Tax Law

One of the pleasures of being an academic is that you get to teach students who are eager to learn about something that you care a lot about.  One of the pleasures about being an academic who teaches tax law is that you get to teach students who are eager to learn about something that matters a lot--a whole lot, in fact.

There couldn't be a better time to be a tax prof.  I just met a group of eager young candidates for law school who came to our open house earlier today.  They heard about the Wayne Law experience from professors, students, adminstrators and alumni.  They learned that they will have a challenging and thrilling career, one that demands hard work and commitment, but one that rewards immeasurably, from the warm feeling of helping a fellow citizen deal with a crisis in that person's life to the justifiable pride in making a difference in community, state or nation, in the ways the laws work to create a better society.  It is, quite simply, a genuine pleasure to be a part of that community, even though at times the committee meetings are a burdensome chore, the exam writing and grading is an experience that would not be missed at all, and the administrative headaches, paperwork, and must-dos sometimes seem to have multiplied until desk, the floor and the windows can't be seen because of all the paper.

I appreciate the opportunity to be a part of my students' lives, to help challenge them to make the world a little better, and to challenge myself to continue to explore the ways that tax impacts us in our daily lives.

More on Banks, and Modifying Home Mortgages in Bankruptcy

An article on the housing crisis is available on SSRN, just at the time that Congress reconsiders the question of whether homeowners should be permitted to modify their mortgage loans in bankruptcy, just like every other debtor can do, for credit card debt to debt on the purchase of that luxury yacht.  John Eggum, Katherine M. Porter, and Tara Twomey have published Saving Homes in Bankruptcy: Housing Affordability and Loan Modification, 2008 Utah L. Rev. 1123.  Here's the abstract:

This article examines the home affordability of chapter 13 bankruptcy debtors under current law, which prohibits the cram down or modification of residential mortgage loans. Using original empirical data from a national study of over 1700 chapter 13 bankruptcy cases, it analyzes the relationship between housing costs and income for bankrupt households. More than two-thirds of homeowners in chapter 13 bankruptcy live in unaffordable or severely unaffordable housing, according to the standards developed by the Department of Housing and Urban Development. Such families spend more than 30 percent of their incomes at the time of bankruptcy on paying their mortgages and related housing costs. The large fraction of their incomes that bankrupt homeowners commit to paying their housing cost reduces the odds that they will succeed in saving their homes in bankruptcy and completing their chapter 13 repayment plans. The Article considers how these data could inform the debate about whether Congress should amend the Bankruptcy Code to permit the modification of home mortgages, offering examples from real bankruptcy cases to show the beneficial effects of mortgage modification to create sustainable homeownership. It concludes that permitting mortgage modification would enhance the usefulness of bankruptcy as a tool to address the foreclosure crisis.

The House passed Rep. Conyers' bill this week.  Now the Senate needs to act.  Hopefully, the Senators will read this information and recognize that modifying mortgage indebtedness in bankruptcy could help solve the foreclosure crisis, and thereby help solve the current deep economic crisis.  We learned on Friday that 651,000 jobs were lost in February, sending the unemployment rate to 8.1%. Goodman & Healy, Continuing Job Losses May Signal Broad Economic Shift, New York Times, Mar. 6, 2009.   That article notes that the "800-pound gorilla is whether we face up tot he bad loans in the financial system"  Id.  That means, from my perspective, (i) letting bank shareholders eat the losses, so that the good assets can be separated off to keep the bank system working, (ii) reinstituting the Roosevelt-era lines between commercial banks and investment banks, so that ordinary Americans' hard-earned savings are not put at risk by greedy investment bankers' speculative risk-taking, and (iii) making sure that a strong anti-trust system prevents any one financial institution from ever again growing "too big to fail."  But if those jobs translate to even one-tenth that number of homes in foreclosure, the poverty, homelessness, and deteriorating neighborhoods problems will continue to mushroom.  So the other 800-pound gorilla in the room is the foreclosure crisis itself.  Congress needs to enact bankruptcy reform now, while it can make a difference in dealing with this crisis.

Private Debt Collection of Federal Taxes a Thing of the Past

IRS Commissioner Doug Shulman has announced, "after a thorough review", that it will end the experiment in using private debt collectors when the current contracts with two private debt collection companies expire today (Mar. 6).    IRS Employees More Flexible, More Cost Effective, IR-2009-19, Mar. 5, 2009.   "The program costs about $7.6 million a year to administer, and private contractors are allowed to keep about a quarter of the taxes they collect."  Ohlemacher, IRS to drop private debt collection program, Mar. 5, 2009.  Collections under the program were not very successful.  After the first year of the program, the contractors had collected only about $29 million in back taxes, amounting to less than 4% of the $787 million of back taxes they were assigned to collect.  But they got to keep a staggering $6.35 million of the $29 million collected--not bad pay for the easiest tax debt collection work.  See Donmoyer, Private Debt-Collection Plan Ended by Internal Revenue Service, Bloomberg.com, Mar. 5, 2009.  The IRS's review found that collection costs for the privatization program were much higher than for government work:  24 cents per dollar collected, compared to 7 cents per dollar collected by the IRS.  Lawder, U.S. IRS to end contracts with private tax debt collectors, Reuters, Mar. 5, 2009

Instead, the agency will rebuild its own employee base that was decimated under the years of GOP treatment, beginning with Reagan's "revolution" in the 1980s, that cut funding for many of the most important federal agencies (other than, of course, the military, which instead enjoyed unprecedented budget buildup), leaving them short-staffed and unable to execute the laws appropriate, thus carrying out Reagan's pro-business, anti-government philosophy that viewed government agencies as part of the problem rather than important players in a complex society requiring public and private cooperation.  As many as 1,000 new IRS collection staff may come on board this year under this change of plans.  Shulman indicated that those employees will provide "flexibility to make assignments based on the areas of greatest need rather than filtering which cases can be worked using contractor resources."   IRS Employees More Flexible, More Cost Effective, IR-2009-19, Mar. 5, 2009.  Private debt collection had sent the easiest cases to private companies, a process that made little sense.

When the GOP-dominated Congress passed a bill permitting private collectors to do the government's job, Democrats almost immediated began work to end the program, "raising concerns about its effectiveness and reports of taxpayer harassment."   Lawder, U.S. IRS to end contracts with private tax debt collectors, Reuters, Mar. 5, 2009.  Shulman's review found that collection costs for the privatization program were much higher than for government work:  24 cents per dollar collected, compared to 7 cents per dollar collected by the IRS.  Id.   Similarly, ataxingmatter noted several problems with that approach, including the following: (1) privatization for the sake of eliminating government agencies is inappropriate for quintessentially governmental functions, like tax collection, where the behavior and liability of the private parties cannot correspond to the same requirements for government employees, (2) privatization of the primary debt collector role doesn't make sense when the government must ensure the accountability by retaining staff to oversee the private staff, as is the case with private debt collection of federal taxes, (3) privatization of the "easiest" part of the government function most assuredly is senseless, since it allows private companies to grab an easy (and undue) profit from the prime collection targets, leaving government employees, as always, to struggle with the difficult ones, and (4) privatization of debt collection, for reasons related to 1-3, probably costs more money than having the government do the job directly.  The National Taxpayer Advocate has had similar concerns since the program started, and has openly advocated for an end to the experiment.  See, e.g., National Taxpayer Advocate Report to Congress and Private Debt Collection, July 9, 2008 (noting excessive costs of PDC); Private Debt Collection of Federal Taxes: National Taxpayer Advocate continues to condemn it, Mar. 15, 2008; Private Debt Collection of Federal Taxes: Letter from Senators in advance of Shulman Confirmation Hearing, Jan. 29, 2008; Private Collection of Federal Taxes: Efforts To End It, Feb. 22, 2007;  Outsourcing of Tax Collections, Sept. 12, 2006; Day, IRS Urged to Abandon Private Debt Collection, Washington Post, Jan. 10, 2007 (noting Olson's view that "the IRS could do a better job and for less money").

Democratic chair of the House Ways and Means Committee Charles Rangel, speaking to a reporter for Dow Jones Newswires, said that he "applaud[s] Commissioner Shulman's decision to end the private debt collection program. American taxpayers deserve to work with the trained professionals from the IRS to work through any issues they have."  Meanwhile Charles Grassley, Ranking Senate Republican on the Finance Committee, "blasted the decision" for cutting a job-providing program and blamed union political pressure. Vaughn, IRS Eliminates Debt Collection by Private Agencies, DowJones, Mar. 5, 2009.  CBE Group, one of the two remaining contractors of the three originally participating in the program (the other is Pioneer Credit Recovery, a subsidiary of Sallie Mae), is based in Waterloo, Iowa.  Donmoyer, Private Debt-Collection Plan Ended by Internal Revenue Service, Bloomberg.com, Mar. 5, 2009. 

Rangel has it right, and Grassley is just joining the rest of the Republican party in blaming unions for all things that don't go the Republicans' way.  Fact is, unions are probably much more concerned about jobs for everyday workers than Charles Grassley.  Workers at those debt collection agencies will likely have plenty of work in these difficult economic times--banks, hospitals, retailers, and manufacturers are hounding people for debt payments and often hire collectors to do their dirty work.  And the decision will create 1000 jobs.  Now, that's a pretty good deal--save the government a lot of money by doing it for 7c/dollar collected instead of 24c/dollar collected, AND create a thousand new jobs!

Banks: More on UBS, More on Merrill bonuses, and More on Mortgage Loans in Bankruptcy

More on UBS:

After Swiss bank UBS admitted helping US clients hide their assets offshore through establishment of shell companies (and thus evade US taxes on those assets), the US and Swiss bank UBS signed a deferred prosecution agreement, under which the big Swiss bank agreed to provide 300 names of US holders of its offshore accounts.  It also agreed to pay almost $800 million in fines and penalties.  A full accounting of the deferred prosecution agreement, as well as links to the text of various relevant items, is available at the earlier ataxingmatter post, here.

That post notes an important statement from Peter Kurer, the chair of UBS's board of directors, repeated here for readers' convenience.

"Client confidentiality, to which UBS remains committed, was never designed to protect fraudulent acts or the identity of those clients, who, with the active assistance of bank personnel, misused the confidentiality protections embedded in the QI Agreement with US authorities by providing false declarations regarding their tax status."  UBS News Alert, Feb. 18, 2009. 

The repercussions from the admission, and the Swiss government's decision to allow the release customer names by the bank under the deferred prosecution agreement, have reverberated through the Swiss economy and the banking industry.  As of today, Peter Kurer, on the job just one year, will not be the chair of the board after the bank's annual meeting on April 15.  He will not stand for re-eleciton, and will be replaced by former Swiss Finance Minister Kaspar Villiger.  (UBS's chief executive officer Marecel Rohner already resigned a week ago, being replaced by Oswald Grubal.)  The IRS has sued UBS for the release of 52,000 client account names--suggesting that the IRS believes that most of those US citizens who hold accounts through UBS may be engaging in tax evasion, and Mark Branson, the CFO, testified at Levin's March 4 hearing that the bank would not turn over any more names.  Swiss Finance Minister Merz has indicated that he is willing to collect taxes on offshore accounts on behalf of the United States, and Swiss Justice Minister Eveline Widmer-Schlumpf has indicated that the government will cooperate on cases of "gross" tax evasion.  Since the Swiss banking industry accounts for a significant portion of Swiss GDP (8.5% in 2007) and jobs (130,000 people or 4% of the workforce), this could have a major economic impact there.  But the bank makes a lot of money in the United States, and Switzerland may find itself unable to sustain its bank secrecy laws. See Logutenkova and Gallu, Swiss Suffer Secrecy Loss to Sustain Money Management Franchise, Bloomberg.com, Mar. 6, 2009.

Sen. Levin's Senate Permanent Subcommittee on Investigations is not likely to drop this.  Levin called Swiss bank secrecy a "cash cow" that lets tax cheats cheat honest taxpayers.  One way or another, he will push for a resolution that ends the advantage for US citizens of parking their assets in a shell company set up by foreign banks.  That means the Swiss will have to get rid of their unprincipled distinction between banking secrecy that protects tax evasion but not tax fraud.  Levrat, quoted in the Bloomberg article, seems to understand that.   

More on Merrill Bonuses:

If UBS's willingness to support wealthy Americans in evading their US tax obligations in return for big fees for the bankers isn't enough for you, you might want to know even more about big banks and bankers' greed.  Here's the story for you.  Bank of America is claiming that it will suffer "grave and irreparable harm" if it has to identify publicly the Merrill Lynch emmployees that got $3.6 billion in bonuses when their firm (Merrill) was lossing billions and being taken over (with lots of taxpayer money greasing the takeover) by Bank of America.  Those employees in an insolvent losing business got bonuses out of taxpayer money, and they don't think they should be identified, because it would allow other bsanks to "poach" talent.  the top four bonus recipients got a total of $121 million, next four $62 million, next six $66 million, according to Cuomo.  Read more on Bloomberg, at this link.

More on Modifying Mortgage Loans in Bankruptcy:

I've said from the beginning of this crisis that a key component of any resolution must be a change to the bankrupcty provisions to permit bankrupcty judges to modify home mortgage loans by reducing the principal of the loan, forcing the creditor to take a hit.  John Conyers introduced the "Helping families Save Their Homes Act" (H.R. 1106) in the House.  Under pressure from the banking lobby, House Democrats worked out a compromise to get it passed, keeping the cramdown provision in place but narrowing the legislation: the compromise requires borrowers to showw that they have tried to modify their loans with lenders before seeking court help, and judges must consider whether the homeowners have been offered a reasonable deal by the bank.  See AP, Democrats agree to limit loan modifications by bankruptcy judges, Mar. 4, 2009.  The House of Representatives passed the Conyers bill with the modification today (Thursday, Mar. 5), and now the action moves to the Senate.  The bill also (i) raises the FDIC borrowing authority, (ii) includes incentives to get lenders/servicers to modify mortgages outside bankruptcy and (iii) amends the Federal Deposit Insurance Act and Federal Credit Union Act to increase deposit coverage permanently to $250,000. 

In the past, banks have lobbied successfully to prevent the possibility of home mortgage loan modification in bankruptcy, in spite of the fact that almost every other kind of loan can be worked out, including those for huge private yachts or vacation homes, and they've worked hard, through the Financial Services Roundtable lobbying group, to kill this bill, too.  They wanted to do anything to prevent such bills, because at first, they wanted to keep making money from their loans and later, they were hoping against hope that house prices would rebound.  Neither of those reasons apply now, so one has to assume that they really don't want those actual values to show on their balance sheets, proving them insolvent.  For information on the banks' lobbying, see, e.g., Grow et al, How Banks Are Worsening the Foreclosure Crisis, BusinessWeek, Feb. 12, 2009 (with video, discussing the "lobbying effort aimed at diluting, forestalling, obstracting and delaying" efforts to change bankruptcy provisions); Hirschfeld Davis, House set to approve bankruptcy mortgage workouts, Mar.4, 2009, Baynews9.com. 

Banks argued, for example, that the provision would create a wave of bankruptcy.  There may be some increase in bankruptcy because of the possibility of saving one's home, but that is actually a benefit of the bill, not a detriment of it.  We want people to be able to save their homes, since the economic crisis will end sooner rather than later if people are not out on the streets homeless.  Further, at this point it would be difficult to claim that bankruptcy is increasing solely because of this bill--there are many other reasons for bankruptcies to increase during an economic crisis with significant job loss.  The banks also argued that they are concerned about homeowners' access to mortgage loans, since modification in bankruptcy will cause lenders to charge higher rates.  Id. That argument doesn't hold water, since foreclosures (which are the main alternative to reduction of principal in bankruptcy) are these days more of a money-loser for banks than modifications--they don't sell the houses for enough to pay off the loan, and they've got considerable transactions costs (maintenance, selling fees, etc.) to contend with.  Consumer advocates have long argued that this bank show of concern is false.    Furthermore, there is something else to keep in mind--banks' efforts to sell homeowners on costly subprime mortgages led to many of those homeowners now finding themselves in bankruptcy.  The banks should be held accountable for their part in this economic crisis, and homeowners should be able to stay in their homes, neighborhoods avoid the deterioration of foreclosures, and the economic crisis be settled sooner rather than later. Brave New Foundation has a video on homeowners suffering (and brokers' greed).

Links Worth Noting

Len Burman, Would Obama's Plan to Curb Deductions Hurt Charities?, Tax Policy Center/TaxVox, Mar. 3, 2009.  Burman examines the critics who argue that cutting the deduction for charitable contributions (by limiting the value to 28%) will hurt charities.  After going through some calculations to see what kind of effect might be expected, Burman (tongue in cheek, perhaps) suggests that we should just "increase top rates even more and eliminate the deduction limit.  Assuming that contributions are sensitive to the tax price, this would unleash a flood of philanthropy and produce revenue for the Treasury at the same time." (emphasis added)  Hmmm.  Good idea.

Brad de Long and Konstantin Magin (forthcoming 2009), The Equity Return Premium: Past, Present, and Future, Journal of Economic Perspectives.  (posted on Berkeley's Political Economy Working Notes and Papers, Sept. 5, 2008).  Comforting thought--de Long predicts that there will continue to be an equity premium, though it might be closer to 4% than the traditional 6% that we have come to know and love.

Ken Houghton, at Angry Bear, The Two Sides of AIG, Mar. 2, 2009, provides a helpful discussion of the scandal at AIG.  Remember that we are bailing AIG out because it is "too big to fail" (meaning we sat by while it gorged itself, and fattened its managers and owners, on plump fees for taking the loss positions in credit default swaps written on hypothetical ownership of bonds as bets on the market).  The reason it is too big to fail, Angry Bear reminds us, is that it's counterparties would lose if AIG can't pay off on all those swaps.  And who are those counterparties?  Why, just the same big financial institutions that we are also bailing out with our other hand under TARP--Goldman Sachs, Deutsche Bank, Marrill Lynch and company.  Isn't it nice to know that all those billions of bailout money are staying in the family, so to speak.  Now is anybody getting angry enough to demand that the Obama Administration go on and nationalize the banks before the shareholders have picked off every scrap of meat on the old U.S. bones?  If  you can stomach more on AIG, read on at Naked Capitalism, AIG Restructuring Leaving Best Bits to AIG, Not US Taxpayers, Mar. 3, 2009, and on Paul Krugman's Blog, The Conscience of a Liberal, All your downside are belong to us, Mar. 3, 2009 (asking who are AIG's counterparties that we are subsidizing, a question answered in part on Angry Bear, and why the government is getting so little for taking on so much of the risk).  A commenter on Krugman's blog adds an important point--why not charge the counterparties a premium for the government's reinsurance role in insuring AIG's swaps?   Another suggests that companies that are "too big to fail" are probably also "too big to save".  So, Geithner, what do you say to that?  Ultimately, more transparency is needed, soon, else another commenter's lament may fill all our thoughts--"The question remains as to how we get the unvarnished truth out of these scoundrels, and then how do we deal with thecatastrophe?...The continued lies...are not an option I favor, no is pouring more money after bad.  How do we stage a citizens revolt?"  John, at this link.

Mark Thoma, Ridding Ourselves of the Zombies, Mar. 3, 2009, refers to Arin Dube's analysis of the problematic financial sector and the real alternatives facing the Obama administration--some form of liquidation (nonintervention or organized); or continued bailouts ("zombies on life support").  Nonintervention would likely allow the market forces to weed the zombies out over time, but we don't have time (and the destruction of vulnerable people would be significant).  Life support--what we are providing now with the TARP funds-- will keep the going for a while, but if this is really a solvency crisis (which of course it is), there is no principled reason to keep pumping blood into a dead beast.  The right answer here is  organized liquidation, which in this case is a planned public policy of nationalization.   So why hasn't Obama bitten the bullet and started the process of restructuring the banking system?  Because the powers that be are very powerful.  Commenter Bruce Wilder adds:

The struggle to reform bankruptcy law, to aid ordinary folks with a mortgage under water, can be beaten down.  The auto industry may be forced into liquidation.  But, AIG? Citibank? There's no limit.  "Because the system is in jeopardy.  We have to save the system."  Extortion in broad daylight.  See comment.

Dani Rodrik, What do Philippe Aghion and Dean Baker have in common?, notes that a bunch of economists support the Employee Free Trade Act.  Good for them all, and good for US workers, too.